Expense Recognition

EXPENSE RECOGNITION

The production, sales, or cash receipts method can be used to assign revenues to periods of time. Expense recognition involves assigning or matching expenses to periods of time. Some expenses are closely related to the revenues assigned to periods of time. For example, the costs of goods sold during a period reflect the costs of materials, labor, and manufacturing overhead incurred to produce units of product that were sold. These costs are called product expenses. Other expenses are closely related to the periods of time to which revenues are assigned. For example, costs are incurred to maintain sales and marketing organization, a research and development capability, and a general administrative organization. These costs are called period expenses, because they are closely related to the periods during which these organizations and capabilities exist. When to recognize costs as expenses is one of the most perplexing problems the accountant faces. It is easier to describe what should not be done than to describe what should be done. For example, whether the costs have been paid for with a disbursement of cash has little to do with the determination of whether they should be recognized as expenses. Thus, the electricity consumed in lighting a store is an expense of the period in which the electricity is used, even though the electric bill has not yet been paid. That is, the electricity expense is a period expense. If the electricity is used to run a machine in producing a product, then the cost of the electricity becomes a part of the cost of the product and is not considered an expense until the product is sold. That is, the electricity cost is a cost of product, which becomes a product expense when the product is sold.

Labor costs in a manufacturing situation are considered to be an asset until the product that was produced is sold. They become part of the cost of inventory and are only regarded as part of the cost of goods sold when